Tuesday, October 30, 2012

Oh, I just cannot resist this, :-). So the Great October Surprise turns out to be a monster Frankenstorm/Snowicane combining a hurricane with a nor'easter that happened to show the lowest pressure readings at its center ever recorded for a storm north of Cape Hatteras. Is Sandy a message from God or Mother Nature or Whomever or Whatever about the current presidential election? While some argue that it may favor Romney, I find almost everything about it likely to tilt the other way in its "recommendation."

1) Republican Governor Chris Christie of NJ, obviously a leading candidate for the GOP nomination in 2016, has publicly praised both Obama and FEMA in unequivocal and unstinting terms for their handling of the crisis. This contrasts with the pathetic performance under Bush of FEMA after Katrina (emphasized by Brownie criticizing Obama and FEMA for "moving too fast," hack, cough).

2) Suddenly there is attention on Romney's statement back in June that he wanted to abolish FEMA, and that funding it is "immoral." Of course, he has since denied this, but today was refusing to answer reporters' questions about whether he wants to eliminate it or not.

3) There is also attention on the fact that the GOP House, with Paul Ryan among the leaders of this along with Eric Cantor, pushed hard for major cuts in disaster relief aid. This was a major part of one of the repeated holdups in budget negotiations that have happened. More embarrassment.

4) While Romney has called for sending responsibility to state governments, his own record as Governor of Massachusetts is a major embarrassment in this regard. He provided no aid for flood relief to Peabody and Greenfield in the state when they were flooded. In the case of Peabody, it was flooded again during his term after he had turned down aid earlier for it after its first major flood.

5) While Obama is acting as Commander-in-Chief and overseeing well-managed FEMA operations, Romney held a supposed "Red Cross Relief" event in, gasp, Dayton, Ohio, on a day of supposed "no campaigning." This amounted to asking for people to provide goods to be given to the Red Cross, with Romney being photographed receiving them, with lines of his supporters waiting to give them to him. The only problem with this is that the Red Cross has publicly stated that they do not want goods, but money instead. However, people giving money does not provide a photo op.

6) While neither candidate has mentioned "climate change" during this campaign, it is well known that Romney has publicly agreed with climate skeptics during the primary campaign and has opposed any new climate-related legislation, even though as Governor of Massachusetts he had a more reasonable view (more flip flopping). OTOH, in his first two years when the Dems controlled the House, Obama did propose a climate bill that got through the House, whatever one may think of it (and it was pretty flawed), only to have it filibustered to death by the Republicans in the Senate. Once the House went GOP, with Tea Party ravers denouncing climate science as a "hoax," it was clear that there was no point in trying further on that route, and any mention by him of climate change in the campaign would have brought a frenzy of ads in Ohio charging Obama with threatening autoworker jobs, with white male workers in auto-related industries in that state probably providing the ultimate pillar for his reelection.

So, I am not going to make any statement about the existence or nonexistence of deities or grand natural forces with intent, and I am also not going to predict how ultimately voters will swing or respond to anything in particular here. But I will be very surprised if after this we see any more serious claims in the media about "Romnentum," or whatever. There really is nothing in this for Romney other than goofy whining about Obama spending a lot of money to deliver some pizza to campaign workers in Orlando, Florida this past Sunday. Poor guy; I almost feel his pain... :-).

Sunday, October 28, 2012

The German composer died the other day at the age of 86, productive until near the end. Listen again to Das Floß der Medusa (The Raft of the Medusa), that tells the story behind the painting by Géricault. Forget about the inflamed politics of its first performances in the ‘60s, just listen to the music and follow the haunting text, with its quotations from Dante. Imagine the singers drifting across the stage, from the world of the living to the world of the dead. Let this artist hand off his dream to you.

I just got around to seeing this wonderful Iranian film (in video). This comment will be semi-spoiler, so read at your own risk.

It is fundamentally a work of social criticism, in the realist tradition of European class and American racial dramas. Its target is the criminal justice system of Iran, in particular two elements. First, the law recognizes the personhood of a fetus, so that every miscarriage is a potential act of murder. Second, criminal cases are regarded as conflicts between plaintiffs and defendants in the same way as civil cases; it is not “the state versus me” but “you versus me”, and I can get you to drop charges by bribing you. Put these two together and you get the possibility of legalized extortion, as portrayed in the film.

You could make a dull, didactic movie that made this argument, but if you had the talent you could make something as wonderful as “A Separation”. Its virtues are the virtues of the best realism in general. It doesn't preach but shows. The truth is read on the faces of its characters, not proclaimed in speeches. The characters are symbolic (avoidance versus stubborn resistance), but they are complex, and the line between what is admirable and regrettable is ambiguous. Above all, the film is rich with the particularity of realism: the physical details of a hearing room, the sounds of groups of people milling in a waiting area, the long moments of waiting that occur even in the midst of life-changing events.

The central point of view largely belongs to the eleven year-old daughter of the separating couple. It is through her eyes (literally) that you see the truth that it is the measure of an unjust system that it compels you to act dishonestly. The film ends with a question posed to the viewer, whether to fight or flee, but in the form of the daughter’s choice of custody, and you feel, as she does, that the choice itself is unfair.

In case it isn’t already clear, the film is technically and stylistically near-perfect. The camera angles are just the right mixture of naturalistic and disorienting, the pacing is taut but never rushed, and the acting is thoroughly convincing. It is gripping to watch, a film you would find fascinating even if it had no point to make. I wish, at this time of enormous economic injustice, we could have a film that treats class in America with the same clarity, drama and artistic integrity.

Saturday, October 27, 2012

Romney has said he would have saved money by relying on private finance to move the big three car companies through bankruptcy, although he’s been extremely vague as to how he would have reached that outcome without committing the vast federal resources that the Bush and Obama administrations did to achieve it. Romney claims that the two presidents overspent by billions of dollars by doling out federal loans when mere guarantees of some sort paired with an earlier bankruptcy might have gotten the job done for cheaper. But Summers, echoing the opinion of industry experts, CEOs, and Republican politicians in Michigan who supported the bailout, said the kind of resources necessary were impossible to find in the private sector under any circumstances. The Detroit News editorial board made the same case this week even as it endorsed Romney. “There was not private money available,” Summers told TPM on a conference call with reporters Friday. “And there wasn’t Congressional authority for the federal government to start guaranteeing loans ot the automobile companies.” At the time, the top financial firms around the world were facing their own existential crisis, having just received hundreds of billions of dollars in government aid during the economic crash. The auto rescue ended up requiring about $80 billion in aid from across the Bush and Obama administrations. That would have been by far the biggest debtor-in-possession bankruptcy loan in history had the private sector stepped in per Romney’s plan. The previous record? $8 billion to Lyondell Chemical in early 2009 — and it came with huge interest rates and fees. Summers argued that the level of debt at the car companies’ required whoever financed them to take a large equity stake. And if the federal government didn’t take that equity, taxpayers wouldn’t benefit when the companies turned around. “Guaranteeing loans to the automobile companies in the necessary quantity without getting an equity stake so that when the company succeeded you profited from the upside would have been far more costly to the federal government,” he said.

Larry is relating what a lot of us have already noted but I guess Mitt Romney is still too ideologically driven to understand the basic point. TPM reader made an excellent point:

Its actually slightly worse than you say. Towards the end of the op-ed, Governor Romney almost in passing proposes government loan guarantees. That is, it would have been a pure privatized- gain, socialized-loss transaction. A Bain type entity would have bought the company with very little equity. A huge new government guaranteed debt would have been undertaken for the company. The old debt would be subordinated to the new debt through the bankruptcy process. The new debt would be very low interest rate, since it would be backed by the full faith and credit of the United States. So, to this extent, the idea that no funding would have been available for the company is, strictly speaking, false. The Bain type entity would have set about repudiating pension obligations and otherwise cutting costs. If it works, the new owners who bought the company with very little of their own money at risk get very rich. If it fails, well, hey, there are the government loan guarantees. Note that there is absolutely no upside for the taxpayer guaranteeing the new debt. The gains are strictly for the job-creating superhero private equity guys.

Friday, October 26, 2012

Thanks to John Weeks, I see this quote from Merkel speaking before the Bundestag last week:

We have made good progress on strengthening fiscal discipline with the fiscal pact but we are of the opinion, and I speak for the whole German government on this, that we could go a step further by giving Europe “real rights of intervention in national budgets”.

The idea is that fiscal orthodoxy is soooo important, and individual countries shouldn’t be allowed to tinker with it. If they try to run deficits outside the (narrow) boundaries of the Fiscal Pact, officials from Brussels should step in and overrule them.

Germany, as is well known, is (or tries to be) a paragon of orthodoxy in macroeconomic affairs. Of course, Germany also has a social market economy which violates almost every principle of orthodox microeconomics. And what happens when proposals are put forward to regulate any of that stuff from Brussels?

You can see the answer in the stalemate over banking regulation. As part of a quid pro quo for centralizing the lender of last resort function at the European level, an attempt is being made to assert European control over the oversight of financial institutions—and Germany is fighting it tooth and nail.

Germany, you see, has about half of its financial sector assets in public banks. These are run by state officials whose job is to promote local economic development. They are given large implicit subsidies and permission to calculate their equity cushion in ways that private banks aren’t. (Implicit state support is seen as equity.) Meanwhile, Brussels is dominated by the orthodox view that all public subsidies and political influence should be removed from the financial sector, so that money can flow freely to wherever it can earn the highest rate of return. Equity should mean share ownership, and shares should be freely traded throughout the EU.

On this issue I side with Germany: public banking, for all its faults, plays a crucial role in their economic model and has contributed enormously to its productivity and export success. (This is true, above all, for the Mittelstand sector of small and medium enterprises.) Giving in to the rigid liberalism of Brussels would be a mistake.

Our orthodoxy for you? Of course. Yours for us? Never. It is interesting that there seems to be near-zero awareness of this contradiction within Germany, although it is screamingly obvious to an outsider. As Levi Strauss said, culture is unconscious, and this is true for political culture too.

Thursday, October 25, 2012

Deborah Solomon provides some important political news as well as a bit of good policy analysis. Mitt Romney has told us we need to somehow fix the alleged long-run solvency problem for Social Security. Let’s assume for the sake of argument that either future taxes must be raised (something a few progressives advocate) or future benefits must be trimmed (guess which one the Republican nominee is advocating). Here’s where I think the analysis should begin:

As Jed Graham noted in his 2010 book "A Well-Tailored Safety Net," Social Security actuaries have previously indicated just how much workers at various income levels would have to save as a percentage of their incomes over the course of a career to offset benefit cuts.

Deborah tells us that Jed is her husband but he does have a good framework here. Whether my taxes will go up in the future or my benefits will go done, I’d like to know how much I’d have to decrease my lifetime consumption as a result and still end up with the same retirement portfolio. With this in mind, let’s read what Romney is proposing:

A close look reveals just how difficult it will be to close Social Security’s ballooning trust fund shortfall without new taxes, which he promises to avoid. It also shows that Romney’s approach will hit middle-income workers harder than the wealthiest, which may come as a surprise given his oft-repeated comment that he'll slow the growth rate of Social Security benefits for those with "higher incomes." As outlined, Romney’s plan closely resembles one proposed in 2006 by another Republican, former Utah Senator Robert Bennett. Both exempt people 55 and up, raise the retirement age to keep up with longevity gains (about one month every two years) and adopt some form of progressive price indexing that has benefits for the top grow only with inflation, while benefits for the lowest earners continue to reflect real wage gains. While Romney’s campaign hasn’t specified details when it comes to progressive price indexing, there isn’t much room for flexibility. Social Security Administration actuaries found that Bennett’s plan would cut promised benefits for a 22-year-old average earner -- someone making about $45,000 per year today -- by about 24 percent and a maximum-earner (making $110,000 and above) by about 35 percent. That seems progressive. But looks can be deceiving ... For an average earner, saving 1 percent of wages a year, investing it in Treasuries and cashing it in for an annuity would offset a 10.3 percent benefit cut. That means a $45,000 earner would have to save 2.3 percent of income, or $1,000 a year, to offset the 24 percent cut under the Bennett plan. Meanwhile, someone earning $110,000 would have to save 2.1 percent of pay to offset a 35 percent benefit cut (each 1 percent of pay saved can replace 16.8 percent of benefits for top earners). That means a $1 million earner, who pays Social Security taxes on only $1 of every $9 earned, would have to save just 0.23 percent of income to offset benefit cuts.

That sounds like a regressive proposal to me. Now I’m sure Team Romney will try to deny all of this but Ms. Solomon should be congratulated on some excellent reporting.

Wednesday, October 24, 2012

David Warsh at economic principals, http://www.economicprincipals.com/issues/2012.10.21/1429.html has provided useful information about Lloyd Shapley from the book by Sylvia Nasar on Nash (A Beautiful Mind) and the book on the origins of game theory by Robert Leonard (Von Neumann, Morgenstern, and the Origins of Game Theory). Nasar emphasized the personal rivalry of Nash and Shapley, who both started in grad school in math at Princeton at the same time, and who also shared the same major professor, the late Albert W. Tucker, who coined the term "prisoner's dilemma" and was also co-developer of the Kuhn-Tucker theorem (not all of this is in either book or Warsh's post). Nasar emphasized this rivalry more from its egotistical aspects, who was smarter than whom, rather than its intellectual aspects, although Dave does refer to those.

These become clearer in the discussion from Leonard who recounts how Shapley was working at RAND in 1948 and successfully challenged von Neumann on a mathematical point. As a result, von Neumann reportedly offered Shapley a stipend to attend Princeton, which got him there to contest with Nash intellectually and personally. However, while Tucker was Shapley's major prof, his real mentor, von Neumann, was not formally a member of the math dept., but rather of the Institute for Advanced Studies nearby. In particular, he followed von Neumann in becoming a deep student and advocate of the use of cooperative game theory, which usually ends up being the study of coalition formation and interaction. This would lead him to develop the idea of the core in economic theory, as well as some of his other major ideas, including the Shapley value from his thesis, and his analysis with Shubik of power relations in groups. He would later coauthor a book with Robert Aumann on these matters in 1974, with Aumann publicly proclaiming him "the greatest game theorist of all time."

Now Nasar also reported on the rivalry of Nash with von Neumann himself. As with Shapley, much of this was personal and egotistical, who was the better mathematician than whom. They met once, and there are sharply conflicting reports about what transpired, although all agree that it was not a particularly friendly encounter. A strongly pro-Nash account appears in Nasar's book, while a strongly pro-von Neumann account appears in Machine Dreams by Phil Mirowski, who is a great fan of von Neumann's work (if not his person). While I was editor of JEBO, an author submitted a paper that claimed to determine which account was more accurate, but I demanded that this be removed from the paper, noting that the only primary sources for what happened were either dead or insane.

As it is, however, there was real intellectual substance to the debate as well, namely the rivalry between the cooperative and the non-cooperative approaches to game theory. Of course, the latter was advocated by Nash and formalized in his famous equilibrium that was the basis of his thesis. In the 1970s this would be the foundation for a major revival of game theory, with the Harsanyi and Selten extensions of it forming the basis of their co-receiving the Nobel with Nash in 1994, the first given for game theory. By and large, Nash's solution became far more cited than the earlier work of von Neumann or the later work of Shapley, and most would say that Nash "won," with the '94 prize, the book by Nasar, and the subsequent Oscar-winning movie starring Russell Crowe, simply reinforcing this victory.

However, along comes this prize for Shapley, and people like Warsh suddenly noticing that there have been no books on Shapley equivalent to that on Nash (who has been a more dramatic figure personally, although Shapley is plenty eccentric). There is more here than just people siding with Mirowski or the people (Harold Kuhn in particular) who were feeding Nasar with her information over von Neumann versus Nash, with so much emphasis on personalities. Without doubt non-cooperative game theory has been immensely important and useful. But it is probably now time for people to take more seriously its long discounted rival, cooperative game theory, once again.

Saturday, October 20, 2012

Last spring I was interviewed on our local NPR outlet about energy economics. Among other things I pointed out the well-established costs of pollution from fossil fuels relating to global warming and health issues from SOX and NOX. I urged the standard well-known green technologies along with thorium nuclear reactors, noting the irony that the US did not pursue this technology after carrying out the first thorium fission experiments in the 1950s because this could not be used to make nuclear weapons, along with other now desirable features (safer, more thorium around than uranium, etc.). The show was rebroadcast recently without anybody telling me, and many more apparently heard it and I was bombarded by various comments and inquiries. One friend asked why I did not note the defense spending costs associated with oil as part of the issue. Given that my friend George McGovern now lies in a hospice at age 90 no longer responding to the communications from his family, perhaps this is an appropriate time to address this more closely.

I responded to my friend's inquiry (which came through facebook) by noting that in contrast to global warming or health costs of SOX and NOX, it is much harder to determine how much of defense spending is for "protecting our sources of oil." Indeed, this is a very difficult matter, although thinking about carefully suggests to me that not much really is, which also suggests to me that the position I agreed with and helped support of McGovern's that we did not need nearly as large of a DOD establishment as we had and have remains correct. Its budget is often justified to the public on precisely these grounds, but the reality is quite another story.

So, let us simply focus on the Gulf wars as an example, and, to sort of simplify things let us focus on the second of these, our recently concluded war in Iraq (although we continue to spend DOD money there with some residual troops, etc.). For starters there is disagreement on how much it cost. At the upper end are estimates by Stiglitz and coauthors of as high possibly over the long run as $3 trillion. This includes all the medical costs of everybody wounded and much else. The direct military costs appear to be just a bit under $1 trillion, which gives us a reasonable range. But how much of this was really about "protecting our sources of oil"?

Indeed, my response to my inquirer was that this is a matter of great uncertainty, and the more I think about it, the less I think that it had anything to do with it, even when those running policy thought that it did. Now indeed it is not a new position of mine that the Iraq war was not "really" about oil, although many people whom I respect think quite the contrary, that it was all about that and nothing else. Well, I will grant that the real motivation of the first Gulf war under Bush, Sr. was about oil. When Indonesia invaded and annexed East Timor, nobody did squat, and likewise when India did the same in Sikkim (although there was more noise about that one, given the glamor connections of some of the wives of the Sikkimese royal family). But Bush Sr. arranged a global alliance to push Saddam Hussein back out of Kuwait, even though it appears that his goals were fairly modest, to grab a small slice of Kuwait, based on old border disputes from the setting of those borders by the British after WW I. The Saudis and Bush feared Saddam really wanted to run all the way down the Gulf to grab the big prize of al Ghawar in Saudi Arabia out of which nearly 5% of the world's oil supply flows. And maybe that was his goal, along with conquering Mecca and declaring a new Caliphate as some have argued. In any case, Bush Sr. succeeded in pushing him back out of Kuwait and wisely listened to the Saudis who said, "Do not go to Baghdad," much to the annoyance of some of his underlings, most significantly, Dick Cheney.

So, when Bush Jr. came in, his VP Cheney played a nasty game with him, playing to his masculine insecurities vis a vis his dad, urging him to be like Reagan and "finish the business and take out Saddam," although Reagan pulled out of Lebanon the minute terrorists attacked our embassy in Beirut and killed a bunch of Marines. For Bush Jr., this was what the war in Iraq was about, not oil. And for a bunch of his other advisers who pushed the war it was also not about oil, but about Israel, the neocons such as Wolfowitz, given Saddam's ridiculous habit of paying the families of Palestinian suicide bombers $25,000 when they died. Oil had zip to do with this, indeed, the matter of Israel has always been a contradiction in the story of US Mideast foreign policy, with the US oil companies viewing US support of Israel as an annoying distraction from their love fest with the Saudis and other Arab and Muslim (Iran once upon a time) oil producers.

Of course, Cheney was a different story. He had personal interests, notably the company that he formerly ran, Halliburton, and it remains a scandal that Halliburton made so much money out of the war in Iraq, whatever Cheney's personal take from that was, although in the end the major portion of this had to do with supplying the US military with all sorts of goodies rather than actually making money out of engaging in oil business in Iraq or elsewhere in the Gulf. Now, Cheney does appear to have been plotting more generally to be a pinup boy for an old imperialist vision: bring back the major US oil companies in a serious way into the Gulf oil business, or at least at a minimum, into the Iraqi oil business. And some of the neocons also were under the delusion that the Iraqis would be so grateful to us that they would pay for our invasion of their country from their oil revenues, like the Kuwaitis did for Bush Sr., the main reason the first place to be taken in Baghdad was their Oil Ministry building.

But in the end, this was all for nought, a pathetic farce and delusion. The war is over, and not only have the Iraqis not paid us a penny for our efforts, the US oil companies have been cut out of the action almost entirely in Iraq, where indeed oil production is reviving gradually after the collapse that occurred as a result of our invasion. Of course, oil production in Iraq is now controlled by two distinct political entities, Iraq and Iraqi Kurdistan, where rising oil production involves a variety of foreign oil companies, although not universally legally recognized. Most of the companies in Kurdistan are small independents out of Norway and Canada and other such places, with the only US companies involved there being some owned by the Hunt brothers, one of whom sat on Bush Jr.'s Foreign Intelligence Advisory Board. This created a minor scandal at the time, that he was profiting from inside intel info, but that faded away, leaving them the only US oil companies making money out of the definite gains for the Kurds from our invasion of Iraq. As for the main oil fields in the rest of Iraq, US companies viewed them as too risky due to ongoing military conflicts to seriously bid, and as a result, the old operators in Iraq got most of the deals, namely the Russians and the French companies, along with the new big player, the Chinese. To the best of my knowledge, no major US oil company is making any serious money out of Iraq, although I think there a few minor deals going on.

Of course, there is more controversial issue here. What really is the "US national interest" here? Most think that it is a matter of keeping the oil flowing so that price of oil in the US for our consumers does not get too high. Even now, the threat of Iran blocking the Strait of Hormuz, given our nuclear conflict with them, remains an apparent justification in the eyes of many Americans for our humongous defense spending, or at least some of it. But in terms of Iraq, the main result of our invasion was to cause a decline in oil production in Iraq, something warned of by the major US oil companies in fact, who perhaps wisely foresaw that our intervention there was not going to make them any serious long run profits. But this decline in oil production did help US companies, their one compensation, in that it led to a rising price of oil, which helped their profits in the short run, even as it sucked money out of the pockets of US consumers. In terms of the official public traditional view of "protecting our oil sources," if this meant for US consumers enjoying lower prices it was a total flop, although it did lead to gains for Cheney's pals in the oil industry from the higher prices for awhile.

So, the bottom line here is that in fact nearly zero of the spending for the war in Iraq actually "protected our sources of oil," certainly not for consumers, and not even in the longer run for US oil companies. Anybody trying to defend the scale of US defense spending on the grounds of "protecting our sources of oil" should be run out of town on a rail after being tarred and feathered.

Friday, October 19, 2012

This came up when I was writing homework problems on adverse selection for a money and banking class and without intending to, wrote one that had 2 equilibria.

Take the market for used cars a la Akerlof. There are 10 potential buyers and 12 potential sellers, 4 each with cars of Low, Medium and High quality. Buyers reservation prices are 15, 10 and 5 thousand dollars for High, Medium and Low quality, respectively. Low Quality sellers need at least 3, Medium sellers 7, and High sellers 11 thousand dollars. Quality is known to sellers but not to buyers, who know only the distribution.

There is an equilibrium at a price of $7500, in which Medium and Low quality cars sell, but no High quality. The expected value of a car for buyers is is $7500. Excess demand is 2, but at a price above 7500, there is excess supply as no buyers are interested, since it will be above the expected value of $7500. At prices above 11, the expected value of a car will be $10,000, so no deals will be made at such prices either.

Think about what happens as we drop the price below 7500. 10 buyers are interested and 8 sellers until we hit 7000. At that point , only low quality sellers will be selling, so the buyer reservation price drops to 5000, and we have no buyers therefore until we hit 5000. This is the second equilibrium: there is excess demand of 6 below and at this price, but excess supply of 4 just above it. Only low quality cars are for sale. This second equilibrium is Pareto-dominated by the higher-price equilibrium.

Now imagine that the sellers are workers, with reservation prices representing opportunity costs, and buyers are employers whose reservation prices represent productivity. And that productivity is private information for the workers. Then we can get an interesting rationalization for a Card-Krueger positive relationship between employment and the minimum wage. The market suppose is in the $5000 wage equilibrium: imposing a $7500 minimum wage would put the market in the better equilibrium with higher employment.

With a little hand-waving and mutatis mutandis, it seems one could get a rationalization of anti-usury laws. Here the bad equilibrium would be the high interest rate equilibrium, with only the lowest quality borrowers wanting loans. Then an anti-usury law can produce the low interest rate equilibrium, where the average quality of borrowers is higher.

This is probably old hat to most, and to the extent that I haven't made glaring mistakes, the idea has I'.m sure been developed with orders of magnitude more sophistication by others. When I google scholared "adverse selection and multiple equilibria" I get lots of hits, including what looks like a seminal paper by Charles Wilson which I printed out and plan to read right now. But sometimes simple examples can be helpful at isolating the way a mechanism works, so I thought I would pass this one along.

Noah Smith has an excellent discussion of what he calls “Reinhart-Rogoff vs. Bordo-Haubrich (with grandstanding by John Taylor)”. Please read it as it has become part of the Presidential debate about whether we should condemn the Obama Administration for the slowness of this recovery or we should understand that recoveries from financial crisis are often slow unless our politicians have the wisdom to use massive fiscal stimulus (which Obama originally wanted but the Republicans said no). Noah at one point fired off this shot:

First of all, do not listen to John Taylor. He is not being a scientist right now, he is being a politician ... And I think no one should take John Taylor's promotion of B&H's results seriously, since he is part of Team Romney.

While Taylor does link to Paul Krugman, both he and Mankiw ignore Noah’s post. I guess we could point this out in the comment section of their blogs but guess what – they do not allow comments. Hey – that is their right but would it be too much to ask for them to cite the well written posts on this topic from other economist bloggers such as Noah? Oh wait – as members of Team Romney I guess it would be too much to expect them to engage in an honest debate? Never mind!
Update: Noah correctly notes that John Taylor's latest was posted before his excellent post. Note, however, Greg Mankiw's list was posted just today and Greg failed to include Noah's post. So Noah is being very kind and fair to John. We shall see if John follows up and includes Noah's discussion on his blog.

Thursday, October 18, 2012

You would think that everything that needs to be said about this topic has been put on the table in the past few weeks. (I will skip the links; these posts have already been linked to death.) And you might be right, but I’ll offer a different take anyway.

The debate has been cast in an aggregative framework in which the set of welfare-relevant individuals includes both those who pay taxes tomorrow to repay today’s deficits and those who hold the bonds and receive payments. Fine, but let’s consider a narrower question, one that most economists apparently think is beneath discussion: what it is the purely fiscal burden of public debt?

Well it’s obvious, isn’t it? Either you pay off the debt in the future or you roll it over and pay more interest. Either way you bear a fiscal burden, and they are the same in present value terms.

Well, try this. In thinking about the fiscal burden, it may help to imagine a country with two types of citizens. One type pays taxes but owns no financial assets; the other owns financial assets but pays no taxes. (We’re getting there....) The government runs a fiscal deficit in period 1. In subsequent periods will there have to be offsetting transfers from the taxpayers to the bondholders?

First step: I rule out the scenario in which any significant portion of the debt is paid down. This is not a deduction from theory, just an empirical observation. Fiscal surpluses are few and far between. Tomorrow’s taxpayers will no more be paying off the public debt incurred by the current generation than today’s taxpayers are paying off the debt bequeathed to us by our parents and grandparents.

So let’s get to step 2 and consider interest payments on the debt. Here the critical move is to regard the burden not as a sum of money but a fraction of income, the debt service to GDP ratio. This goes up if and only if the percentage increase in debt exceeds the corresponding percentage increase in income, given a constant interest rate. (I abstract from the issue of real versus nominal incomes and interest rates.)

Now, why would anyone think that the incremental effect of a fiscal deficit on future income growth would be positive? Two reasons. First, if the deficit finances public investment, and if this investment is more productive than the use to which the money would have otherwise been put, income will grow commensurately. Second, if the deficit reduces an otherwise stubborn income gap, hysteresis effects are likely to boost potential income in future periods. The extent to which income growth attributable to deficits offsets debt service obligations and therefore raises or lowers the future fiscal burden is uncertain.

But that’s the point. I would say it is an open question whether any particular deficit will be burdensome in the most restricted meaning of that term. The answer is likely to vary from one macroeconomic context to another, from one program of public spending to another, according to the extent of the deficit, and so on. The bottom line, however, is that, even if all the government bonds are owned by Martians so that taxpayers and bondholders are completely different species and transfers from the first to the second constitute a pure welfare loss, there is still no determinate relationship between more deficits today and more burden tomorrow.

Wednesday, October 17, 2012

Aaron Sekhri provides a summary of a discussion at Stanford between Kenneth Arrow and John Taylor. I wish I had attended but based on this summary, Taylor is very confused about the role that fiscal policy plays during a recession even after Arrow stated the standard Keynesian position when the economy gets stuck in a liquidity trap:

He went on to discuss the disadvantages of what Obama opponents see as key fixes, namely, reductions in government spending. “Spending cuts are not productive,” he argued. “The real problem is the underutilization of resources. We can’t cut down what is really an investment in the future.” … Arrow then began a discussion of the need for government spending at a time when interest rates bottom out, as they did after the 2008 financial crisis. “The problem with monetary policy is that when the interest rate gets to zero, you hit a limit. That’s what happened in the Great Depression, and I’m probably the only one in the room who remembers that time,” joked the 91-year-old Arrow. Taylor argued in response that “temporary spending, such as the stimulus program, peter out very quickly and do not give you sustainable growth.”

Sustainable growth is what economists worry about in terms of full employment economies over the longer term. Does Dr. Taylor even get the basic premise that we have deviated from the long-term full employment path? Of course, Dr. Taylor has a simple solution to how we get back to full employment:

Comparing the federal government’s attitude towards change to the intransigence of the stubborn parent-teacher association at his child’s school, he asserted that the best route to economic wellbeing was to remove the incumbent administration and start anew.

In other words, make Mitt Romney President and everything will magically get better by itself. If you were not convinced by now that John Taylor has turned transformed himself from economist to political hack, this statement should make that case.

Sunday, October 14, 2012

The New York Times has a piece this morning on California’s new law to regulate carbon emissions, the corporately named Global Warming Solutions Act. (Here is our new 2012 lineup of global warming solutions; pick the one that’s best for you.) It is utterly uninformative about what is at stake in this new program and the damage it is likely to cause.

The author of the piece makes what must have been a pleasant journey to a redwood forest in order to talk with the folks who measure tree diameters: tree growth means carbon storage and provides a physical audit of carbon credits for forestry. Journalists love this visual stuff, but accurate tape readings are almost irrelevant to the true problems predictable under the California law.

There are two huge issues, either one sufficient to sink the entire experiment. The first is that carbon permits are given away to businesses based on historic emissions. The second is the gaping loophole of offsets.

Giving away permits is very attractive to politicians. Overnight they are in a position to grant or withhold vast sums of monetary equivalents, and this is sure to induce correspondingly large campaign contributions. In other words, the logic of carbon giveaways is the same as the logic of our tax laws: they are convoluted and larded with special exemptions because otherwise there would be nothing to sell.

But worse, giving away carbon permits creates an unsolvable contradiction for policy. On the one hand, freebie permits transfer money from consumers to businesses to the extent that the permits are scarce. Issue fewer permits and prices go up, but costs to producers stay the same because the permits are free. From an economic point of view it is a lot like the supply restriction enforced by cartels, except that here the government is in charge of squeezing the market.

Of course, what these handouts giveth to businesses they taketh away from the rest of us. Voters don’t like to see the prices they pay go up, especially for highly visible items like gas and home heating. They are even less likely to appreciate their contribution to the windfall profits of industry. So here is the conundrum: permit giveaways are justified as the price that has to be paid to get business to go along with a climate plan, but the same system alienates voters and guarantees that serious limitations on carbon emissions will never occur. You can see the outcome in the European Trading System, which ended up authorizing so many permits that they now have no value at all and no longer trade: the system “restricts” carbon emissions to the level that would occur in its absence. My fearless forecast is that California will go the same route.

As for the problem of offsets, if accurate tree measurements is the main hurdle, we are in heaven. Much more likely are two other glitches. First, the criterion of additionality, that the green investments being subsidized would not have been made without the sweetener of an offset, is impossible to enforce. How can anyone prove that a forest would or would not have been harvested in a parallel universe, exactly the same as our own, except for not having a Global Warming Solutions Act? The history of the Clean Development Mechanism, set up under Kyoto to funnel carbon offset money to green investments in less developed countries, demonstrates that to a fault; independent audits have found that improper subsidies are the rule, not the exception. On top of that, the criteria for offset eligibility are easily gamed, and many “green” projects are anything but, except in one narrow sense that allows the money to flow. (Imagine how easy it would be to game any formal criteria for forestry offsets—cutting one forest more while collecting money by cutting another less, turning forests into tree plantations that trade sustainability for more rapid short-run growth, permitting practices that release more carbon from forest soils, etc.)

The offset game gets support from those whose noses are buried in the minutiae of carbon accounting. Trees capture x amount of CO2 equivalent, equal to the combustion of so many barrels of oil or tons of coal, so why not trade one for the other? Alas, this ignores the underlying logic of climate change. The last century has seen a dangerous trend toward global warming not because of deforestation (which has been going on since the beginning of settled agriculture), but because of the release of large quantities of carbon that had been sealed away underground for hundreds of millions of years. The bottom line of forestalling catastrophic climate change is leaving as much of that stuff in the earth as possible.

Specifically, there is enormous, and enormously complex, exchange between atmospheric, terrestrial and marine stores of carbon. No one can say today how much of the carbon fixed in tree growth will be released over the next century, particularly since environmental conditions are certain to change radically. For instance, those wonderful redwoods described in the Times article may turn out to be in the wrong latitude as temperatures rise. This would be reflected in an increase in the frequency and severity of fires, which would send the carbon back up into the atmosphere. Or people may not wait for fire to do the job; they could change the laws and start cutting the trees themselves. What happens to carbon after it is extracted from the earth’s mantle is complex, fragile and reversible; it is the rate of extraction that has to change.

The good news is that this is just about California. Governments in other places can try to do a better job. Unfortunately, as the leading experiment in the US, the California system will be viewed as casting a verdict on all attempts to forestall climate change by pricing carbon, and its predictable failure will set back policies good and bad. Those who care about this issue shouldn’t wait until the moment when failure becomes visible. There is still a limited opportunity to construct an alternative narrative: this plan is so compromised that can’t work and isn’t a test of climate sanity.

Friday, October 12, 2012

I just had an epiphany which I’d like to share with you: the neutrality of money is baked into the standard supply and demand diagram that enters the first-year economics brain and never leaves.

Recall the following point: putting together all the factors on which sellers base their preferences, and all the factors on which buyers base their preferences, an equilibrium price is determined. If the actual price is above this equilibrium, excess supply will generate downward pressure until equilibrium is reached. If the actual price is below, excess demand does the job. It doesn’t matter what the price happens to be at the moment; it will gravitate toward the same equilibrium which has been determined by factors other than this price.

That embodies the neutrality of money. By “money” I mean not simply the price level, but also the full range of effects generated by the financial system. Financial activity can alter the prices of individual goods: commodities markets influence the price of minerals and agricultural products, markets in mortgages and their derivatives influence the price of homes, and so on. The financial sector, in a money-neutral world, is determined by but ultimately does not determine the “real” world of production possibilities and preferences. That is why finance can be an add-on to economic models that can be specified with or without it. In a money-non-neutral world, everything really does determine everything else, with no distinction between “monetary” and “real”.

For some people the logic of the supply and demand diagram is a reason for accepting this neutrality. For me it’s a reason to take a closer look at the model and question what subtle, long-lasting mental poisons we are releasing into the environment each time we (economics professors) teach it.

The answer, we know, is locked in those infamous ceteris paribus conditions. This becomes transparent at the level of general equilibrium, where Sonnenschein-Debreu-Mantel tells us that changes in actual prices have the power to alter their equilibrium levels. If you really, truly understand this, you see money and finance differently. The problem is how to convey this same insight at the level of the simpler, more visible models on which introductory economics is based. It’s hard to repair the damage caused by years of learning “the economic way of thinking”.

Mark Thoma is very upset with the latest from Jack Welch and he should be. But let’s be calm and look at a couple of Welch’s two key claims:

In August, the labor-force participation rate in the U.S. dropped to 63.5%, the lowest since September 1981. By definition, fewer people in the workforce leads to better unemployment numbers. That's why the unemployment rate dropped to 8.1% in August from 8.3% in July. Meanwhile, we're told in the BLS report that in the months of August and September, federal, state and local governments added 602,000 workers to their payrolls, the largest two-month increase in more than 20 years.

The first claim is true – the labor force participation rate did fall from 63.7% to 63.5% but Welch conveniently omits the fact that this same rate rose from 63.5% to 63.6% as of September. And who told Mr. Welch that reported government employment shot up by over 600 thousand workers in just two months? I guess this person may have been Neil Cavuto or perhaps Donald Luskin because when I checked out the same series per FRED, I see an increase of only 55,000 over the past 3 months. As our graph shows, we have seen a very mild reversal of the unfortunate downward drift of government employment (I'm using seasonally adjusted data here - Mr. Welch didn't say what he was using and his claim is not even consistent with the data not seasonally adjusted). In all of his rants, Mr. Welch has proven only one thing – he is utterly clueless per the employment statistics that the professionals at the Bureau of Labor Statistics report. Before he decides to attack their integrity again – might I suggest he actually learn something about what they report?

Monday, October 8, 2012

ABC’s This Week invited Nobel Prize winning economist Mary Matalin to debate known liar Paul Krugman. OK, I think I got this backwards even though Matalin did say:

I don’t make up numbers ... you have lied about every position and every particular of the Ryan plan on Medicare from the efficiency of Medicare administration to calling it a voucher plan ... You are hardly credible on calling somebody else a liar.

Actually - it was established a long time ago that Mary Matalin is a partisan hack but what about this claim:

Has there ever been this not be true in history that the deeper — the deeper the recession, the steeper and stronger the recovery. There is no such thing as a deep recession with a moderate recovery.

Fact-checking financial recessions is a salient issue, especially in a US election year. On the one hand, the incumbent faces criticism that the recovery is slow. In August the Mitt Romney campaign invoked US history to argue that performance has been poor: “The 2007-2009 financial crisis produced a severe recession ... But GDP growth has been anaemic since then, averaging just 2.2% per year since the trough. This pattern is unusual. The past ten recessions have been followed by faster recoveries, and GDP has fairly swiftly recovered to the previous trendline.” On the other hand, none of the last ten US downturns coincided with a financial crisis. In his convention speech nominating Barack Obama a month later, Bill Clinton intimated that the usual pattern in normal recessions was not relevant in this instance: “The difference this time is purely in the circumstances… no president, not me, not any of my predecessors, no one could have fully repaired all the damage that he found in just four years.” ... We reach back into the historical record over 140 years, examining the experiences of 14 advanced countries, to document the pervasive cyclical influence of credit in the economic fortunes of nations … The more excess credit in the preceding expansion, the worse the recession and subsequent recovery appear to be ... By this reckoning the US has done quite well, steering out of the to-be-expected financial recession range based on the inherited level of excess credit, especially if the shadow system is considered. Most importantly a deep financial recession was avoided at the outset, and this level effect remained intact ... To assume that this US recovery would resemble previous “normal recession” is to use the wrong benchmark.

There is a very simple way to think about this using standard IS-LM thinking. The 10 recessions from the late 1940’s to 2001 (see this for the dating of US business cycles) differed from the Great Recession as well as the Great Depression in terms of the ability of conventional monetary policy to quickly reverse these milder recessions. In those 10 situations, we could have and actually did reverse these recessions by allowing interest rates to fall. Some of these recessions (notably the ones from 1969 to 1982) were started by deliberate monetary contractions to “Whip Inflation Now” as President Ford once quipped. The ability to rely on monetary expansion had lead many economists including myself to wonder if we ever really needed fiscal stimulus to manage downturns in the modern business cycle. Yes – more fiscal stimulus would have been called for during the Great Depression but not in the modern US economy – unless we fell victim once again to the liquidity trap. The financial crisis in other nations such as Japan should have warned us that falling into a liquidity trap was a real possibility but I guess we had to relearn the lessons of history on our own. When Barack Obama prevailed in November 2008, he seemed to realize the need for a massive and effective stimulus package but alas didn’t push hard enough for what Christina Romer recommended. And alas, US fiscal policy has recently drifted towards austerity. So while I agree with those who argue that policy responses to severe financial crisis are different than policy responses to garden variety recessions, all this really means is that we may have to look beyond conventional monetary policies to have quick and effective remedies to downturns in aggregate demand. Alas the Republican Party and Team Romney to date has been opposed to fiscal stimulus unless it is of the military Keynesian brand.

Sunday, October 7, 2012

Bradley Klapper thinks the story is that Mitt Romney insulted Spain during the Presidential debates. Perhaps but let me extract the relevant economic portion of this story:

“I don’t want to go down the path of Spain,” Romney said Wednesday night during the first presidential debate. He argued that government spending under Obama has reached 42 percent of the U.S. economy, a figure comparable with America’s NATO ally. “I want to go down the path of growth that puts Americans to work.” … No one contests that Spain’s situation is dire, its economy in deep recession and unemployment hovering around 25 percent. But Spain’s level of government spending is actually low by European standards, and significantly less than Germany and Scandinavian countries with far healthier economic prospects. Spain’s woes were chiefly caused by the collapse of a property bubble that had fueled more than a decade of booming economic growth.

Klapper is properly noting that the U.S. recession and the Spanish recession were both caused by similar private sector events. The U.S. has fared less badly than some countries because we at least tried a bit of fiscal stimulus for a little while. Romney has been confused whether we should follow the UK’s disastrous austerity or use military Keynesianism. As far as Spain Matt Yglesias provides a nice graph showing how fast the changed in nominal government spending in Spain has declined:

If the entire argument is really over whether or not this Noteworthy Mercatusward Change in Spanish fiscal policy deserves to be called "cuts" rather than "rapid deceleration" then I suppose we've all wasted our time.

This may not have been the headline lie among all of Romney’s lies during the debate. And maybe Romney was less being dishonest than just completely ignorant of the facts in Spain. But it is very evident that he is either completely ignorant of the macroeconomic situation in the U.S. or is being incredibly dishonest. But hey – what else is news?

Friday, October 5, 2012

Sorry, I can’t help it. Despite all my protestations, in my bones I must be an economist: if I see strategic behavior I have to consider how it could be represented as an outcome of rational calculation. To be honest, however, I did not actually see the first Romney-Obama debate—I am willing to suffer for The Cause but only up to a point. Instead, I am relying on hearsay.

What I gather is that Romney interrupted Obama repeatedly, employing an aggressive personal style and confronting his opponent with one egregious misrepresentation after another. Obama responded with self-discipline to the point of distancing, acting as though he were conducting a calm seminar on politics; he allowed himself to be cut off, and he never confronted Romney with accusations of dishonesty. Score one for Romney; apparently that’s what all the commentators did.

Now put yourself in the shoes of Romney and his advisers. Given the political constraints both candidates face, what is the optimal strategy in the debate game? I think Romney played his cards absolutely right: he provoked Obama to the maximum extent without going so far as to portray himself as a sociopath. The debate moderator (and especially this particular moderator) was not in a position to challenge him. The only resistance could come from Obama himself, and Obama faces the profound constraint of being a black man in America.

Look at it this way: what outcome from this debate would have been even better for Romney? Answer: if Obama had lost his temper, showed personal anger toward Romney and called him a liar. That would have proved to white America that, despite his post-racial stylings, underneath it all Obama is still the angry black militant that evokes a primal fear. Romney can hope, of course: he can think up provocations that would really annoy Obama and make it difficult for him to stay on script. But if Obama draws back from the challenge that’s OK too, as we’ve seen.

If I’m right, we are likely to see more of this in the future. Can Obama fight back without invoking the racial stereotypes that would destroy him? Can he be relaxed and smiling and still twist the knife? That’s a thin line to walk, and if he gets it wrong there would be no recovery. His whole political career has been based on avoiding white panic over aggressive, and therefore threatening, black males. Perhaps his best move is to allow Romney to take all of these debates on points and trust that he has enough other resources to pull out a victory in November. His TV ads can trash Romney without limit, of course, since the voices and images that express anger in them are not black.

None of this has anything to do with political substance, except insofar as racialized judgments regarding acceptable behavior still constitute an important part of American politics in our enlightened year of 2012.

Thursday, October 4, 2012

You’ve likely seen all the documentation you need to know how much Mitt Romney serially lied last night. After all – he never proposed cutting taxes by $5 trillion. And of course he’ll create 12 million new jobs by doing nothing. Actually what offended me more than this was his attempt to deny that part of the Republican agenda was to just sit back and let cash strapped state & local governments lay off public school teachers. But he did admit to one thing - Big Bird should be fired! After all – saving $445 million a year is all we need to do to magically balance the budget if you scribble it on Art Laffer’s cocktail napkin. And we all know austerity is the path to prosperity. Too bad we didn’t have The Count as Romney’s running mate so we can make sure the math all works out just right. But don’t worry about Big Bird as I hear that he is moderating the next debate.

Tuesday, October 2, 2012

In January 1999, a trust set up by Mitt Romney for his children and grandchildren reaped a 1,000 percent return on the sale of shares in Internet advertising firm DoubleClick Inc. If Romney had given the cash directly, he could have owed a gift tax at a rate as high as 55 percent … Romney or his trust received shares in DoubleClick eight months before the company went public in 1998. The trust sold them less than a year after the IPO … In January 1999, Romney’s trust sold $746,000 worth of DoubleClick shares, for a gain of about $674,000, or an almost 1,000 percent return

The extreme undervaluation certainly looks like tax fraud. Key evidence would be the close proximity of the valuation date and the sale date

What was the fair market value of this DoubleClick stock when Romney set up this trust fund? Drucker and Shaviro are certainly arguing that the fair market value was much higher than what was claimed at the time these shares were gifted. We should note, however, that the value of Doubleclick shares has had a controversial history even up to the time that Google purchased the company for over $3 billion during April 2007. About two years earlier, a private equity firm had purchased the company for just over $1 billion:

DoubleClick shareholders will get $8.50 in cash for every common stock share, a 10.6 per cent premium over the average closing price of the company's stock in the last thirty trading days. The valuation is very low compared to DoubleClick's valuation in its hey days.

We should also note that two people commented over at Brad’s place that stock valuations were quite volatile if not exuberant during the late 1990’s. Mind you that I’d be the last to cast doubt on this Drucker-Shaviro claim that Mitt Romney hired some hack appraiser:

But back to the estate attorney who has a Rolodex of appraisers who will give him any whore answer for the right fee. The appraiser/whore that is chosen to evaluate the fair market value of the business has three tricks up his (her) sleeve ... Doesn’t the IRS have their own appraisers that can effectively rebut the bogus valuation reports commissioned by the estate attorney? One would think so – but read most of the Tax Court decisions in this area and realize that even the National Review looks smart and honest by comparison.

Shaviro’s “Key evidence would be the close proximity of the valuation date and the sale date” reminds me of the “expert” testimony in Nestle v. Commissioner of the Internal Revenue Service which involved the value of the various Carnation trademarks and other intangible assets both at the time the U.S. affiliate of Nestle purchased Carnation (January 1985) and when this affiliate sold them to the Swiss parent, which was on April 30, 1985. Nestle had commissioned one appraiser to argue that the value of the intangible assets was approximately $425 million at both dates. The IRS, however, argued that the value of the intangible assets was only $175 million as of January 1985 but accepted the $425 million value for the intercompany sale price as of April 30, 1985. I’m sure if one wished to read the trial court decision which accepted the IRS view one could mock at the quality of analysis by both sides, and the Appeal Court ultimately rejected the IRS position for its own silly reasons. But note that the IRS never bothered to explain why the intangible assets in such a mundane industry could more than double in a period of less than four months. Which is to simply say – both sides often play games when it comes to valuations for tax purposes.